Markets are down again this morning. Most are content to blame it on crude, down about 2 percent earlier on an IEA report that says the world is very adequately supplied with oil, and that demand (particularly from India and China) will not be as strong as anticipated next year.
But I think there's a bigger problem: the central bankers of the world appear to be shifting their positions. Despite the choppy data, a majority of the FOMC appears to be leaning toward a rate hike in September, despite the fact that the fed funds futures are assigning only a 15 percent chance of this happening. It's bigger than that: you not only have the Fed's Dennis Lockhart and Eric Rosengren trying to argue there is a case for raising rates, you have the ECB standing pat on more QE, and don't be shocked if the Bank of Japan's Haruhiko Kuroda turns cautious on expanding QE when he speaks next Tuesday.
So we now have the next eight days—leading up to the Fed meeting—with much higher levels of volatility than you might expect. You can see this in the VIX curve, which has flattened significantly in the last few days. The cash VIX is roughly 17.0, whereas the October futures contract is 17.6, November 18.6. The cash VIX was only 12 on Thursday.
Marko Kolanovic, who runs Derivative and Equity Strategies at JP Morgan, recently estimated that monetary policy since 2009 has accounted for a gain of 21 percent in Low Volatility Equities (consumer staples, utilities, telecom), a 10 percent gain in government bond indexes, and a 7 percent increase in gold.
A 21 percent gain for a Low Volatility strategy is substantial but would certainly not account for all the gains. The Powershares Low Volatility ETF, a basket of low volatility stocks, is up 75 percent since its creation in mid-2011.
Still, it's a substantial part of the gain. If central banks start "normalizing" policy, Kolanovic believes those gains would gradually go away. For example, if the Fed took three years to "normalize" rates at an even tempo, he assumes the average yearly historical gain in equities (about 7 percent) could be erased each of those three years.